The Shadow Market

Flip to backFlip to front

ListenPlaying...PausedYou're listening to a sample of the Audible audio edition.Learn more

Amazon.(above)

The Future Happened Yesterday

Do you ever get the feeling that something's going on in the global economy
that we don't fully understand? That while Americans have been focused on fixing
our wounded economy and worrying about our lost jobs and battered bank accounts,
the world around us was changing in important but nearly imperceptible ways?
You'd be right. It did. Enormous economic changes are taking place around the
globe, many of them hidden in plain sight, others just plain hidden—kept from
the press, the government, and, most of all, the everyday investor. Ever since
2008, when the global financial system melted down, the economic world as we
know it has been flipped on its head. Countries and corporations that once
dominated the planet have been decimated. Meanwhile, other powers have risen in
their place and asserted themselves globally. And although the American economy
appears to be recovering somewhat, and a handful of us are beginning to feel
more confident about the future, the truth is that we won't be returning to
"normal" any time soon.
The structural changes in the global economy have created both dangers and
opportunities. If we ignore them, we may suffer mightily—as citizens, as
workers, and as investors. Our children may suffer even more. The march of
economic history, let it be recalled, is indifferent to your plight or mine. It
doesn't care whether the United States becomes, in a few decades, a weakened,
second-tier economy riddled with debt and unemployment, and beholden to other
countries and a new global currency that is not the U.S. dollar. That could
happen, too. However, if we take the trouble to understand the changes now
occurring, we might be able to make them work to our advantage. We might be able
to get out in front of future economic waves. A few of us may even get wealthier
as a result.
In stark terms, here is what has happened: While our economy tanked, nations
like China and the small oil-rich states of the Persian Gulf, which still had
plenty of wealth on hand, suddenly discovered that they were really rich
compared to the rest of the world. So they started using their cash to seize
geopolitical power. Wealth and influence crept to the East. Meanwhile, America
literally didn't have the money to save itself and the rest of the world from
the financial contagion it started. Our banks and investment institutions
flat-out didn't have the capital to rescue the financial system themselves. By
late 2008, the Bush administration was desperately trying to stave off an
economic panic. That fall, you may remember, as the stock market reeled and
America's largest banks stared at insolvency, the U.S. Treasury Department sent
envoys to China, Singapore, Abu Dhabi, Kuwait, and Saudi Arabia looking for
investments of hundreds of billions of dollars. But Bush's envoys were
completely rebuffed. The problem was that each of these countries already had
been burned by the earlier failures of major U.S. investment banks like Lehman
Brothers and Bear Stearns; they had little appetite for taking on more American
risk. So America plunged into financial chaos as the government was forced to
launch massive bailouts and stimulus programs that will saddle us with financial
obligations for decades to come.
Today we are presented with tangible proof that the era of American economic
hegemony is over. Our fiscal policies and patterns of consumption over the past
few decades have left us with untenable amounts of debt and effectively killed
off our financial empire. For decades, the bulk of the liquidity in the global
capital markets was provided by multinational banks from the United States and
other international financial centers, like the UK and Japan. But today the
global need for investment capital far outstrips the cash that the world's
largest banks can provide. Instead much larger entities with deep reserves of
wealth have emerged to keep the markets flush: a loosely configured, unregulated
global "shadow market" that supplies the money that the world needs to grow.
With remarkable stealth, this network has largely supplanted the United States
as the pacesetter for the global economy. To America, this loss of authority has
been a radical comedown. To the rest of the planet, however, the development of
the shadow market means that a new global economic force is at play—one that
we'll all have to contend with for decades to come.
"The last two hundred years of world history have been a major historical
aberration," says Kishore Mahbubani, dean of the Lee Kuan Yew School of Public
Policy in Singapore and one of the world's leading authorities on the new wave
of globalization. "This is a key point that people in the West have a hard time
wrapping their minds around. From the year 1 to the year 1820, China and India
consistently had the two largest economies in the world. When you think about
it, it's quite amazing that a small continent like Europe was able to conquer
and colonize the world. In many ways this global domination by the West
continued for a surprisingly long time. But I think it's finally coming to a
natural end. So the challenge for the West is, will it accept its loss of power
in the global system or will it resist the transfer of power?"

What is the Shadow Market?

The shadow market isn't a physical entity. It has no headquarters, bourse, or
formal leadership. It isn't even a single zone of exchange in the way that we
typically define a financial market. Rather, it's the invisible and
ever-shifting global nexus where money mixes with geopolitical power. In
specific terms, the shadow market is a collection of unaffiliated, extremely
wealthy nations and investors that effectively run the international economy
through their prodigious holdings of stocks, bonds, real estate, currencies, and
other financial instruments, which they keep in largely unregulated investment
vehicles such as hedge funds, private equity funds, and government-run sovereign
wealth funds, as well as in vast government-owned holding companies. A 2009
McKinsey Global Institute study concluded that, as of late 2008, more than $12
trillion in assets was controlled by such petrodollar states as Saudi Arabia,
Kuwait, and Abu Dhabi; the wealthy Asian nations of China, Japan, and South
Korea; and hedge funds and private equity funds. What's more, McKinsey predicted
that the assets of nations in Asia and the oil-rich Persian Gulf are poised to
grow by more than 50 percent within five years.
This pile of capital is the basis for the shadow market's power, for
liquidity is the key to a functioning market. Looking back more than a century,
nearly every world financial crisis has been caused by a sudden lack of
liquidity—typically during tough economic times, when fear sets in among
investors. At that point, banks and other finance companies start hoarding cash
rather than investing it or lending it out, which, as the United States learned
in 2008, can strangle an economy rather suddenly.
In a capitalist world, the most powerful entities are those that provide the
most liquidity. Since wealthy sovereign nations have the deepest pockets,
they're in the best position to provide the liquidity the market needs. In
practical terms, this transformation can be seen in major real estate
transactions throughout Europe and the United States, where shadow market
countries have been eagerly snapping up trophy properties for what they consider
to be bargain basement prices from their previous highs before Western economies
started tanking.
"Real estate investing in the West in 2010 is really about the financial
crisis," says Fadi Moussalli, the Dubai-based head of Middle Eastern and North
African operations for the global real estate investment consulting firm Jones
Lang LaSalle. "Everything that the [Persian] Gulf States and other rich
countries are buying today has the smell of blood and flesh and distress in it.
Real estate is trading at a discount from its highs of 2007. So this is an
opportunity to benefit from the global market dislocation. I don't think they're
overpaying for these properties. A lot of these guys are my clients – they are
shrewd, they are tough negotiators, and they squeeze every vendor down to get
their price. And right now they're timing the real estate market in the West and
building their portfolios."
Working together, the members of the shadow market could supply enough
capital to stave off any global economic calamity. They have that much money at
their disposal. But the catch is that the members are reluctant to work together
to solve global problems. Instead they prefer to protect their own interests and
zones of influence first. So, wealthy neighbors in the Persian Gulf, such as Abu
Dhabi and Kuwait, will readily cooperate on different projects and initiatives.
But those same Persian Gulf nations are far less likely to go along with a
country like China or Singapore. America once could use its commanding position
as the world's unquestioned economic leader as a galvanizing force behind
cooperative solutions to global financial problems. But the United States can't
dominate this market. Instead it now has to play by someone else's rules.
To get a sense of what this loss of financial control means, recall again the
crisis of 2008, when the United States sought help from shadow market countries
and was rebuffed. To the shadow market, it was too late to bail out America. As
Lou Jiwei, head of the China Investment Corporation (CIC), China's primary
sovereign wealth fund, bluntly told the Clinton Global Initiative conference in
Hong Kong in December 2008, "China can't save the world. It can only save
itself." And that's precisely what China and the other wealthy shadow market
countries did.
Starting in late 2008, China pumped $600 billion of capital into its own
economy in an economic stimulus plan to bolster the Chinese stock market and the
country's businesses. Throughout the Middle East, neighboring countries bailed
each other out, the most notable of which was Abu Dhabi's financial rescue of
Dubai, which ran into serious investment trouble and almost collapsed. In
Kuwait, the country's sovereign wealth fund set up a special multibillion-dollar
investment vehicle that was only allowed to buy shares of local companies in
order to prop up the Kuwait Stock Exchange, which had fallen nearly 40 percent.
None of these expenditures involved permanently saddling the nations with
unmanageable levels of debt. Remarkably, China didn't even have to dip into its
stock reserves during the crisis. The shadow market countries had the financial
or natural resources to support their own economies. The cash-strapped United
States, on the other hand, couldn't possibly embark on such significant
capital-intensive projects. It simply didn't have the money in its coffers. So
its economy suffered—mightily.

Question: How Big is the Shadow Market?Answer: Bigger

So how has this mighty new shadow market emerged seemingly overnight?
Consider a few key points:

For most of the twentieth century, the bulk of America's public debt was
held by institutions based within this country, such as mutual funds and
corporate and government pension funds. But since 2007, more than 60 percent of
our debt has been owned by nonresident foreign investors and independent
governments—primarily rich Asian nations such as China, Japan, and Singapore.
China, the largest owner of U.S. Treasury securities in the world, held $900
billion worth of our debt as of April 2010, according to Treasury Department
figures. And Japan, the next largest holder, held $795.5 billion. These figures
don't count both countries' significant positions in dollars and U.S. corporate
stocks, bonds, and other securities.

China, Japan, and other wealthy nations also have vast investments in global
currencies. For instance, as of July 2010 China's central bank, the People's
Bank of China, announced that it controlled roughly $2.5 trillion in foreign
exchange reserves, which are held by a government-run agency called the State
Administration of Foreign Exchange, or SAFE. In 2006 China passed Japan as the
world's largest owner of foreign exchange reserves. By 2009, SAFE's foreign
exchange investments accounted for nearly a third of the world's total currency
holdings. Still, China and Japan aren't alone. Other major holders of foreign
exchange reserves around the world include Russia, India, South Korea, and
Brazil. Combined, they're sitting on trillions and trillions too.

Sovereign wealth funds(SWFs)are now a global phenomenon. These
government-owned investment vehicles are managed separately from a country's
debt and currency reserves. Aa of July 2010, roughly $3.5 trillion in global
capital was managed through different SWFs, up from $1 trillion in 1999,
according to the Sovereign Wealth Fund Institute. The largest funds belong to
oil-rich nations and industrial powerhouses such as Abu Dhabi, Saudi Arabia,
China, Singapore, Kuwait, Russia, and Norway. Abu Dhabi's SWF alone has more
than a half trillion dollars in assets even after taking a severe hit during the
most recent financial crisis and contributing billions to bail out neighboring
Dubai. That's a lot of cash. And what's more, the International Monetary Fund
(IMF) projects that the total assets managed through SWFs will rise to more than
$10 trillion by 2012 as the size and number of funds explodes. Fast-growing
countries such as India and Brazil are developing plans for their own funds.
Indeed, SWFs have become the height of fashion in global finance. An example can
be found in the fallout of the massive BP oil spill in the Gulf of Mexico that
decimated hundreds of miles of U.S. coastline from Florida to Texas. As the cost
of the cleanup escalated, the value of BP shares was sliced in half. By July
2010, BP executives had become concerned that the weakened company was
vulnerable to a takeover. They needed financial help, fast. So who did they
approach? Not Western banks of the governments of the United States or the
United Kingdom. Instead, they reached out to the real arbiters of liquidity in
the financial markets, the sovereign wealth funds in Abu Dhabi, Kuwait, Qatar,
and Singapore, each of which owned a small position in BP. Kuwait rejected the
request out of hand, but the others remained noncommittal. So why did BP
executives choose this tact? Because they knew that these SWFs controlled enough
cash to easily help the company out of a tight spot in the shortest amount of
time. That's the essence of their power as investors.

Private unregulated investment vehicles such as hedge funds and private
equity funds now set the tone for the behavior of the financial markets. Hedge
funds are unregulated mutual funds that often capitalize on complicated trading
schemes to generate profits. Private equity funds, on the other hand, like those
owned by ultrasecretive firms like the Blackstone Group and the Carlyle Group,
are designed to take over undervalued businesses, clean up the books, streamline
the operations, and resell them for a tidy profit. As of July 2010, hedge funds
and private equity funds controlled more than $4 trillion in assets. Obviously,
that's a smaller pile of capital compared to the vast sums commanded by such
superrich countries as China, Abu Dhabi, Singapore, and Kuwait. Still, these
funds' innovative and sophisticated investment techniques have given them levels
of influence far beyond their size and scope, leading the shadow market herd
into new sectors, securities, and asset classes.

To put all of these numbers and statistics in a broader context, consider
that the McKinsey Global Institute estimates that by 2013, the governments of
countries in Asia and the Persian Gulf, global hedge funds, and private equity
funds will control more than a combined $19 trillion in assets. How much money
is that? Well, in 2013 the gross domestic product (GDP) of the United States is
expected to be around $16 trillion, according to estimates by the IMF. In other
words, a financial force larger than the entire U.S. economy will be at play in
the capital markets. On its own, China's central bank, which controls more than
$2 trillion in assets, is already the largest single investor in the world,
bigger than any major multinational money management firm, from Barclays Bank to
Fidelity Investments to State Street Corporation to BlackRock. And numerous
other wealthy nations aren't far behind China. When you consider everything on
the table, there's really only one conclusion: The shadow market soon will be
the most powerful financial force on the face of the earth—if it isn't already.

Numerous American industries have been gutted automotive, retail, industrial
manufacturing, and the media, to name a few—and American consumers have
struggled with joblessness, high debt levels, and stagnant incomes. As a result,
the United States has stumbled around in a general sense of fear and stasis and
political impotence. But not the shadow market. It's kept moving forward. In
particular, many of the shadow market countries have launched an unprecedented
scramble to buy the world's resources while they're still available. China has
been insuring itself future access to oil, minerals, food, and anything else it
cannot supply for itself. The number of deals around the globe is staggering,
and, in some countries, the presence and power of Chinese companies have
effectively created neocolonial relationships, with Chinese corporations and
officials calling the shots within their own overseas fiefdoms. China also has
projected itself into ownership of the world's cutting-edge technologies in
engineering, computers, and high-end manufacturing. Of course it's not only
China. Other countries, competing not just with the United States and China but
with one another as well, also have been busily scooping up the resources they
need to control their destinies well into the twenty-first century.

What makes the shadow market truly different from, and more dangerous than,
any financial force the world has ever known is the fact that it consists
primarily of independent governments—many of them rivals of America and other
Western nations and all willing to use their capital to advance political,
rather than financial, aims. For centuries, America and other Western powers
have practiced a corporate form of capitalism in which power was derived from
the development of newer and bigger companies. The government's involvement in
the nation's economic system extended to regulation and taxation, but other than
that, it typically tried to get out of the private sector's way. The system was
so successful that economists and political scientists came to the conclusion
that a capitalist economy naturally led to a politically democratic government
on the symbiotic grounds that once people tasted economic freedom, they'd demand
the political variety as well.
The shadow market, however, has turned all of that upside down. For the most
part, the countries of the shadow market have employed capitalist strategies to
amass their fortunes. But even though they've used capitalist tools, many are
hardly "free" countries politically or economically. Instead they adopted a
nationalistic form of capitalism where the state created companies and
investment funds that could participate in the global economy. But the money
generated by these entities doesn't belong to the company, its workers, or its
stockholders, the way in America IBM's profits belong to IBM. Instead most of
the money from these companies and investment vehicles rolls up to the state,
giving the government the power to determine how to deploy the bulk of the
capital generated by its economy.
That's why the shadow market's rise has fundamentally changed the way we view
the economic world. It's not just corporate greed that we have to watch out for
anymore, it's geopolitical power plays as well. Major investors can have
completely divergent agendas from the countries where they're investing, and
sometimes they can make financial moves that have more to do with politics than
economics. This helps explain why in June 2009 China jumped at the chance to pay
$1.2 billion for forty-five million shares of Morgan Stanley to go along with
stock it had bought earlier. The purchase gave China a combined 10 percent
ownership stake in Morgan Stanley, which was in addition to its 10 percent stake
in Blackstone Group. Now China certainly could turn a profit from its Morgan
Stanley position. But investment returns didn't appear to be what the deal was
about. Instead let's say that one day in the not-too-distant future, China
develops an even greater problem with America's dollar policy. Well, it's one
thing for China to approach the U.S. Treasury Department as a rival superpower.
But it's quite another to do it as the owner of 10 percent of Morgan Stanley and
10 percent of the Blackstone Group, not to mention the holder of about $2
trillion worth of U.S. currency reserves and debt instruments.
To make matters even more complicated, there's practically no regulatory
oversight of the shadow market's activities. Why? Because its deals often take
place in foreign countries and therefore are cloaked under the different
financial rules established by each country. So we regularly have no idea what's
happening until after it's happened. The potential for conflicts of interest can
be right on the surface. Yet there's little or nothing we can do about it.
Not that the American government is all that interested in clamping down on
the shadow market's activities right now. Indeed, the global economy has become
so intertwined that our future success is tied to the shadow market's continued
support. As Brad Setser, an economist in the Obama administration's National
Economic Council, stated in his influential September 2008 report for the
Council on Foreign Relations called Sovereign Wealth and Sovereign Power: "The
United States' main sources of financing are not allies. Without financing from
China, Russia, and the [Persian] Gulf States, the dollar would fall sharply,
U.S. interest rates would rise, and the U.S. government would find it far more
difficult to sustain its global role at an acceptable domestic cost."
In other words, through these investments, we've become entwined with rival
nations in conflicting and potentially dangerous ways that we never could have
imagined just five years ago. That's why Michael McConnell, the former director
of national intelligence, told Congress in his 2008 threat assessment report
that one of his most serious concerns about America's long-term security is "the
financial capabilities of Russia, China, and the OPEC countries, and the
potential use of their market access to exert financial leverage to achieve
political ends."
These fears have never been more on target and never more true than today. As
we are about to see, the countries and entities that comprise the shadow market
have been very busily pursuing their new world order, changing the global
economy more rapidly than most people, Americans in particular, ever imagined.

Eric J.Weiner has
covered business and economics for more than fifteen years. His first book,
What Goes Up: The Uncensored History of Modern Wall Street as Told by the
Bankers, Brokers, CEOs, and Scoundrels Who Made It Happen, was named one of
the best books of 2005 by Barron's magazine and one of "The Year's Most
Enriching Reads" by Kiplinger's. A former columnist and reporter for Dow
Jones Newswires, he has written for The Wall Street Journal, Los
Angeles Times, The Boston Globe, and numerous other major
publications. He lives in Great Barrington, Massachusetts, with his wife, Paige,
and their son, Jake.

The Pentagon has run
elaborate simulations of global financial war. Result: America lost, and the
shadow market won.

The U.S. dollar is
under siege as a global currency; oil-producing nations have already begun
secret discussions about replacing it in oil trading.

While Greece was
burning in the spring of 2010, the shadow market nations were spending hundreds
of billions of dollars all over the world rather than helping to fix the
European crisis. Why? Because it wasn't their problem.

With its wealth of
natural resources, Brazil may be more powerful than Germany, France, and Great
Britain put together, and may soon rival the United States for economic
supremacy in the Western Hemisphere.

In April 2009, China
told the International Monetary Fund to sell 3,217 tons of gold. How much did
China buy? That's a secret. What else is China buying? As many of the oil
reserves in non–Middle Eastern countries as it can, including in Canada. It has
bought so many Australian natural resource companies that Australia is getting
nervous. And some would say that China has, in effect, already purchased Taiwan.

Many of the shadow
market countries are racing to improve their food-security risks by buying large
swaths of farmland in other countries, potentially at the risk of starving the
local citizens. Saudi Arabia has a farm the size of Connecticut in Indonesia,
and Korean industrial giant Daewoo controls half the arable land of Madagascar.

Iran is China's
third largest oil supplier and in return receives significant protection from
Chinese diplomats, who are increasingly important players on the
geopolitical stage.

The shadow market
countries will soon control nearly $20 trillion in assets, a sum greater than
the gross domestic product of the United States.

About Me

Robert Searle was educated in Windsor at the Royal Free, the Tutorials, and East Berkshire College. He is the originator of two major "work in progress" Paradigms known as Transfinancial Economics (TFE), and Multi-Dimensional Science (MDS).The former believes that new unearned money could be electronically created without serious inflation notably for key environmental, and
socially ethical projects. Multi-Dimensional Science though presents an unique "scientific" Methodology by which claimed psychic, and spiritual "phenomena"could possibly be "proved".
Apart from the above, Searle has proposed the development of the Universal Debating Project, an interactive "encyclopedia" of virtually "all" pro, and con arguments for practically any subject in the world.He is the creator too of a tribute blog on the musician, and broadcaster David Munrow (1942-1976), and a pioneering one on Contemporary Early Music.Furthermore, he has a very large audio-visual collection of Medieval, and Renaissance Music (manually created as Searle8), and has an "unusual" musical project involving improvisation which could also open up a "new" approach to music.